Small banks tell Fed its Libor replacement doesn't work for them

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Officials from 10 midsize American banks said U.S. regulators' preferred index for replacing the maligned Libor benchmark doesn't work for them.

The Secured Overnight Financing Rate, or SOFR, is appropriate for large banks as a Libor substitute because they have stronger ties to the market for repurchase agreements, according to the letter sent by 10 banks to Federal Reserve Vice Chairman Randal Quarles, Comptroller of the Currency Joseph Otting and Federal Deposit Insurance Corp. Chair Jelena McWilliams. But it's ill-suited for smaller ones, they said.

The bankers who signed the letter object "to the use of SOFR as 'the one alternative' index," according to the document seen by Bloomberg News, which signatory Scott Shay, chairman of New York-based Signature Bank, confirmed was authentic. "A one-size-fits-all approach may not be the most appropriate."

Instead, the banks touted Ameribor, an index specifically created for small and midsize banks by Richard Sandor, a major figure in Chicago trading. The index is based on transactions in the overnight loan market on the American Financial Exchange, which Sandor also founded. Banks said in the letter that they are members of that exchange.

An issue with SOFR, according to the letter, is that it's a secured rate so borrowers using it post collateral such as U.S. Treasurys. But most of the group of 10 banks, who have assets ranging from $8 billion to $60 billion, "do not have large holdings of government securities and therefore can only borrow on an unsecured basis. That presents an immediate asset-liability imbalance and potentially creates distortions in times of financial stress."

That means that when there's a financial crisis, "overnight liquidity becomes a priority and the value of collateral would rise, leading to increased borrowing costs for banks irrespective of their asset size and affecting credit availability," according to the letter.

Fed spokesman Darren Gersh confirmed that the central bank had received the letter but declined to comment on its content. The OCC and FDIC didn't respond to requests for comment.

With less than two years until the London interbank offered rate is intended to be phased out, concerns about SOFR's efficacy from the lending community are growing. In September, chief executives from regional banks sent regulators a letter that expressed doubts about SOFR.

Quarles and Federal Reserve Bank of New York President John Williams sent a letter to members of the Alternative Reference Rates Committee in January about the central bank's intentions to hold a series of working sessions with the banks to understand their needs in the Libor transition.

Bloomberg News
SOFR LIBOR Federal Reserve